Rebalancing a portfolio of shares and bonds will not, on the evidence, increase your returns. Over long periods it typically costs a modest amount. Its value lies elsewhere: it compels you to sell what has risen and buy what has fallen — precisely the opposite of what instinct demands — and it matters most when markets are falling hardest.
Vanguard researchers tested a simple US 60/40 portfolio back to 1926, checked annually and rebalanced only when the mix drifted five percentage points from target. It issued a buy-shares instruction just seven times across eight decades. Every instruction followed a bad year for shares; most followed a terrible one. The last came at the end of 2008, after US shares had fallen 37 per cent.
Consider the context. Banks were failing, headlines were dire, and the prevailing instinct was to exit. The rule said enter. That is the real case for rebalancing, and it has little to do with returns.
Rebalancing doesn’t make you richer
Selling high and buying low sounds as though it should pay. Between shares and bonds, it mostly doesn’t. In their study of US 60/40 portfolios from 1926 to 2009, Colleen Jaconetti, Francis Kinniry and Yan Zilbering compared rebalancing at different intervals against a portfolio left untouched. The untouched portfolio earned the most — but it was also the riskiest, with the highest volatility of the four approaches, and it ended the period 98 per cent in shares. It earned more because it had ceased to be a 60/40 portfolio.
The mechanism is straightforward. Shares carry higher expected returns than bonds, so every time you trim them back, you trim your expected return. Independent research points the same way: Matthias Horn and Andreas Oehler simulated automated rebalancing on the actual portfolios of German households and found no benefit.
Rebalancing within shares — between markets or styles with similar expected returns — is a different question. Jean-Michel Maeso and Lionel Martellini identified a rebalancing premium among S&P 500 stocks. Between shares and bonds, however, anyone rebalancing in the hope of beating a neglected portfolio is likely to be disappointed.
What drift does to your risk
More recent Vanguard work quantifies the drift problem. A portfolio that began as 60/40 in the early 2000s, split across US and international shares and US bonds, had reached roughly 80 per cent equities by the early 2020s without any deliberate decision.
The arithmetic is simple. Take £100,000 split £60,000 in shares and £40,000 in bonds. If shares double and bonds stay flat, the portfolio is worth £160,000, 75 per cent of it in shares. Shares then fall 40 per cent: the drifted portfolio loses 30 per cent of its value. Rebalanced to 60/40 beforehand, it would have lost 24 per cent.
An investor who chose 60 per cent shares because that was the maximum tolerable risk has ended up at 75 per cent without choosing it. Without rebalancing, the market sets your asset allocation — and it sets it riskiest immediately after the best of times.
Why we don’t do it on our own
If rebalancing were merely spreadsheet maintenance, everyone would do it. The difficulty is that it requires acting against ingrained behavioural tendencies. Investors pile into what has risen and abandon what has fallen; recent performance feels predictive. Rebalancing demands you sell the asset you feel best about and buy more of the one you feel worst about.
The resistance runs in both directions. After a crash, buying equities feels reckless. During a prolonged bull market, selling winners feels foolish, accompanied by the conviction that this time is different. Neither feeling is unreasonable in the moment; both lead to a portfolio you never chose.
Household data confirms this. Laurent Calvet, John Campbell and Paolo Sodini studied Swedish households from 1999 to 2002, a period spanning the dotcom crash. Households did respond to drift, but corrected on average only about half of it.
This is the gap a rule fills. A rebalancing rule converts a decision you would otherwise make under fear or greed into one made in advance, under calm conditions. It cannot guarantee compliance, but it changes the question. “Should I buy shares now?” is unanswerable with confidence. “Has my mix moved outside my band?” can be answered in a minute.
The real test is a bear market
Bear markets are where the rule earns its keep, because that is when instinct is strongest and most likely to be wrong. At the end of 2008, rebalancing meant selling bonds to buy shares that had just lost more than a third of their value. Few investors do that voluntarily. A rule does it regardless.
Post-crash entry points illustrate why this can pay. From the 1974 low, US shares returned 15.1 per cent annually over the following 20 years, against 9.9 per cent for bonds (US figures, nominal, before inflation).
There is a cost, and it should be stated plainly. Rebalancing can mean buying into a fall that continues — an investor rebalancing into shares at the end of 1930 watched US shares fall another 43 per cent in 1931. André Perold and William Sharpe demonstrated in 1988 that fixed-mix strategies underperform simple buy-and-hold in sustained one-way declines. Yet from the end of 1931, US shares returned 11.7 per cent annually over the following 20 years. The pay-off is long term, never immediate, and arrives only if you hold to the rule through the painful phase — exactly the phase most investors cannot manage unaided.
How often should you rebalance?
Less often than intuition suggests. Vanguard found no optimal frequency: monthly rebalancing meant twelve times the transactions of annual rebalancing for near-identical results. Checking annually with a five-percentage-point band produced just 28 rebalances in 84 years. Each rebalance carries dealing costs and, outside a tax wrapper, potential tax. Vanguard’s conclusion: check once or twice a year, act at roughly five-percentage-point drift. Some independent studies, including Hubert Dichtl’s work using UK data, find frequency matters more; the evidence is mixed, and the decisive factor is choosing a rule you will actually follow.
Use cash flows first. Vanguard found that directing dividends and interest to whichever asset was underweight delivered most of the risk control with no trading at all, though it cautioned that the high yields of that 84-year sample may not recur. New contributions and withdrawals serve the same function. Within an ISA or SIPP, switching between holdings triggers no capital gains tax.
Alternatively, delegate. Multi-asset funds rebalance automatically — Vanguard’s LifeStrategy funds daily. But no fund can prevent you selling the entire holding in a panic.
A rule set while calm
Evaluate rebalancing not against a buy-and-hold return benchmark, but against whether it kept your risk where you chose it and prevented the wrong action at the worst moment. On that test it succeeds.
My own portfolio holds Vanguard LifeStrategy, which rebalances daily, alongside a diversified set of factor-based funds that rebalance automatically when allocations breach set bands. Neither requires my attention. This reflects no personal discipline — I have structured things so discipline isn’t required. The best rebalancing decision is the one you never have to make.
